Market Failure is not an option; it’s not even possible

Proponents of state intervention in markets (managed markets) unfailingly assert the legitimacy of their stance by pointing to “market failure.” Yes, yes, they admit, markets are great at delivering goods and services to people, but, sometimes they inexplicably fail and this consequently requires men with guns (the state) to “fix” them. To put it simply, market failure is a myth. There is a failure however, not of the market, but of their own ability to comprehend the complexities of a natural system whose chaos is brought to order through feedback.

Appeals for regulation by some central authority are predicated on the ideal of “fairness” in ensuring that all who use some resource pay for such use. In other words, if one perceives even the possibility of “free riding” with regard to some economic good then this is all the excuse needed to bring in men with guns to ensure all pay their “fair share.” Free riding is the quintessential example of market failure. Now, as they say, time to bust that myth.

Now rather than choose an example that would be quite easily dismantled as embodying free rider potential (roads, courts, police, fire protection, etc.) I shall choose what is perceived as the most difficult of all: the environment. For this example we shall use the ever-popular environmental whipping boy, carbon dioxide. The output of CO2, it is said, does not factor in the costs of the damage wrought by this “pollutant.” That is, the externality is not internalized in the cost of the product. In fact the truth is exactly the opposite. To see this let’s consider an economy of two actors, Y & Z. Y produces product y and Z produces z and they trade with each other. Now let’s imagine Y can increase his output if he dumps his waste onto Z’s property. Y can now produce more of y, but Z must now devote time and resources to cleaning up the mess (or perhaps it makes him tired or ill) and thus the output of z declines. Y can now only obtain that smaller fraction of z output when trading. Obtaining less for the same cost is equivalent to a greater cost for the same amount. In other words the apparently externalized cost that Y foisted on Z must necessarily be internalized back to Y by virtue of how his actions affect other actors in the economy. No regulation is needed; it is inherent to the system that for every action there is an equal and complementary reaction.

So now extending this metaphorical example to the real world let us assume for the sake of argument that all the doomsayer prophesies of the climate alarmists are true. Is it not obvious that all these bad consequences would negatively impact economic productivity? So all things being equal, if one sells a barrel of oil for $50 that $50 will now only buy the equivalent of say $40 worth of goods (that is, $40 of goods will cost $50, a de facto market “tax” that precisely mirrors the level of damage as reflected in the decreased output). If the damage predicted by the alarmists is real, then it can’t not have this negative effect. In other words, if everything becomes more expensive because there is less of it, then necessarily less will be consumed, including energy derived from CO2. If the damage is real, this natural negative feedback loop will self-correct the problem as profit seeking people strive to innovate their way to greater production. If the damage is not real, then no correction was necessary.

Ironically, carbon taxes, long touted as a “market” approach to solving this issue would do nothing whatsoever. Energy consumption is relatively inelastic and thus higher prices (taxes) for energy would force prices down in other sectors to compensate. Indeed carbon taxes are already touted as revenue neutral (through lower taxes elsewhere or rebates). The only thing that one might superficially assume could work would be a flat consumption tax on all goods. But even if you could impose a 50% sales tax on the entire economy it would ultimately have no effect on consumption at all. If the money is simply removed from the economy, then deflation takes over and all prices drop. That is, output has not declined, only the money supply. The same amount of goods still trade but with fewer dollars. But, if instead the government spends the money, other than productive losses due to government waste, the supply and demand for goods, including energy still won’t change. With natural market feedback the external cost is internalized as reduced supply; with an artificial system (taxes) supply is unaffected, only the identities of those doing the demanding.

The market system needs no overseer or committee to function. It is not “targeted”, the entire economy would be affected as if with a fever until the profit motive drives the innovators and entrepreneurs to shed the burden of the internalized costs of decreased output. To say that markets suffer failure is the intellectual equivalent of denouncing a fever as a failure of the immune system.